Cisco bounces back on earnings surprise

Results beat negative sentiment, though some remain cautious

DanGallagher

SAN FRANCISCO (MarketWatch) — Cisco Systems Inc. saw its shares jump Wednesday as strong earnings growth and a steady forecast caught Wall Street by surprise following less upbeat results from other high-tech notables last month.

Still, some brokers remain cautious on Cisco
CSCO, +0.31%
, noting that the European economy is still weak and the domestic market for the network-equipment giant faces upcoming challenges — including the so-called fiscal cliff that looms over the U.S. absent a deal among lawmakers by year-end. Read full MarketWatch coverage of Fiscal Cliff

“It doesn’t sound like the upside is likely to sustain,” said Erik Suppiger of JMP Securities in an interview on Wednesday morning. Suppiger rates the stock as neutral.

On Tuesday afternoon, Cisco reported an 18% gain in earnings for the quarter ended Oct. 27, with cost controls helping boost the bottom line beyond the 6% growth in overall revenues. The company’s forecast for the current period was in line with estimates. Read: Cisco delivers positive surprise with results.

Cisco

Cisco CEO John Chambers.

By late Wednesday afternoon, shares of Cisco rose more than 5% to $17.70 — moderating somewhat from earlier gains above 7%. The stock had slumped about 10% since mid-October, when the traditional third-quarter earnings season included downbeat forecasts from tech giants such a Intel
INTC, -0.60%
, EMC
EMC, +0.16%
and IBM
IBM, -1.33%
that also heavily rely on corporate and government spending.

“I think the stock was reflecting a lot of concern about a shortfall in the quarter and the outlook,” Suppiger said, adding that he expects the business to remain “challenging” heading into the new year. “I think Europe is not likely to turn anytime soon. As long as Europe is weighing on global markets, it’s hard to see how Cisco can get more optimistic.”

Wall Street is still largely bullish on the stock, with more than 60% of the covering brokers retaining buy ratings, according to data from Thomson Reuters. The median price target on the shares remains at $22.

“Cisco’s strong results and relatively positive commentary on U.S. enterprise spending stands in stark contrast to the host of IT vendors that have highlighted weakening trends,” wrote Tim Long of BMO Capital in a Wednesday note to clients.

Long rates Cisco outperform, or buy, viewing the stock as “undervalued” given its business fundamentals. “We could nitpick on the gross-margin outlook and Cisco is clearly not out of the macro woods yet,” Long said, “but the execution in the quarter was impressive, and the comments on U.S. enterprise spending should lift the entire networking group.”

Cisco CEO John Chambers said on a conference call late Tuesday that U.S. enterprise revenue was up 9% for the quarter from the same period last year. He said it’s “still too early to call this a trend, but we are continuing to see what we like,” and added that the company is also experiencing strength in the Asia-Pacific markets.

Brent Bracelin of Pacific Crest upgraded Cisco’s shares to an outperform rating following the results, citing his belief that the company “could grow in 2013 and have stable to improving gross margin for the first time in two years.”

Several analysts pointed to Cisco’s low valuation. The stock is trading at about nine times estimated earnings for the next four quarters — nearly 30% below its five-year average multiple of 12.7.

Kevin Dennean of Citigroup noted that Cisco’s results and guidance are not at the same levels as the “blow your doors off” results the company was delivering in years past, “but solid is good enough in our book given undemanding valuation.” He rates the stock as a buy.

Retiring on the 'Fiscal Cliff' edge

(3:49)

One of the biggest risks that retirees and pre-retirees face is that of taxes; not just paying them but the risk that tax policy will change and throw a big wrench into one's plans. That risk-in the form of the fiscal cliff-is now upon us. MarketWatch's Robert Powell reports on Markets Hub.

Some brokers are remaining cautious on the company.

Paul Mansky of Cantor Fitzgerald, who downgraded Cisco to a hold rating on Oct. 17, maintained his view following the results, citing “stiffer comparisons, continued macro-uncertainties and fully discounted cost controls” that will leave few upside drivers for the stock in the near-term.

“We view resolution of the fiscal cliff as critical to Cisco’s ability to deliver in January and April, translating to a likely elevation of uncertainty through year-end,” Mansky wrote.

Brian Marshall of ISI Group also stayed neutral on the shares, saying that Cisco’s gross margins are showing signs of long-term deterioration, having fallen from 70% to 60% over the last decade.

“We believe Cisco’s financial model will continue to experience slow margin erosion in the future (due to weaker mix, increased competition and SDN [software defined networking] trends),” Marshall wrote, “and as a result the investment community is likely to apply a lower P/E multiple to Cisco’s forward earnings stream.”

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